By Andrew Mickey, Q1 Publishing

The recent correction in commodity stocks has caused a lot of investors to ask themselves tough questions. The across the board sell-off in commodities has sparked a big debate about how “super” the supercycle really is.

A rising U.S. dollar and a sharp global economic slowdown (or at least the fear of one) has sent most metal prices down. In just the past few months, the spot prices for base metals like copper, zinc, and nickel are down 12%, 30%, and 42% respectively. The sell-off has hit precious metals just as hard. As I write, gold, silver, and platinum prices are off 20%, 30%, and 35% from their recent highs.

Through this correction, which I’m sure it is just a correction, moly prices have held up very well. In fact, moly prices have held steady throughout the commodity downturn. Is this strength a sign of unwavering demand or merely just a result of a significantly less liquid and transparent market for moly?

More importantly, is it a time to buy moly stocks?

The simple answer is yes, but…with a really big “BUT.” Let me explain.

Moly, like almost every other commodity, has had a good run over the past few years. A pound of moly has climbed from a 2002 low of about $4 up to about $33 today. That’s a run of more than 700%. Moly’s surge has made big winners out of moly producers like General Moly (NYSE:GMO) and Thompson Creek Metals (NYSE:TC).

Moly: A Back Door Energy Play

On top of that, the moly boom shows no signs of slowing down.

You see, moly is used in steel production and is a key ingredient in making steel for oil and natural gas transporting pipelines.

According to the Oil & Gas Journal, there are currently more than 57,000 miles of pipelines slated for construction around the world. It takes 2,500 pounds of moly to make one mile of pipeline.  So that’s $4.7 billion dollars worth of moly need just for pipes, which only account for about 8% of the total global moly market.

Safe to say that moly demand won’t be falling off for quite a while.

The metal is also heavily used to construct nuclear power plants. It takes as much as half a million pounds of moly to build a nuclear power plant.

Demand from nuclear power plants could be the proverbial straw that breaks the camel’s back in this situation.

There are more than 30 nuclear power plants under construction or slated to begin construction in the next few years. The construction of all them would add a total of about 1.5 million pounds of moly consumption to an already tight market.

It’s not just the construction of new nuclear power plants that will drive the demand for moly. On average, nuclear power plants around the world are very old. Most nuclear plants in the U.S. are well over 30 years old and are within a few years of decommissioning. They must be retrofitted and it’s going to take plenty of high moly steel to do that.

The U.S. Geological Survey states, “There is little substitution for molybdenum in its major application as an alloying element in steels and cast irons.”

Since it’s used extensively in these two key areas and there’s no substitute, it’s no wonder the price of moly hasn’t been hit by the recent downturn. But it’s not just demand that has kept moly prices up.

Mind the (Supply) Gap

The supply side of the equation is also helping to keep moly prices bouyant. Last year, 187,000 tonnes of moly were produced globally. That’s only 3,000 more tonnes than was produced in 2006.

That’s a growth rate of less than 2%...it’s not going to cut it.

China, Chile, and the United States produced 78% of the world’s moly last year. We all know China is willing to go the extra mile to put mines into production. Chile is a mining friendly country focused on copper, not moly.  In fact copper mining accounts for 7% of Chile’s GDP. Theoretically, the United States could ramp up moly production but permitting and environmental challenges make this difficult.

There is more moly supply coming on line, but at current growth rates it won’t meed short term demand.

Kevin Loughfrey, Chairman and CEO of Thompson Creek Metals, says, “We think the molybdenum demand relative to those other commodities is strong, and our outlook for the molybdenum continues to be good.”

Jonathan George, CEO of Creston Moly, stated a few days ago, “Molybdenum is trading at around US$33.85/lb but we see it moving up into the US$40/lb range in 2009 bcause there is a stranglehold on molybdenum supply.”

Moly has a lot going for it. Demand is growing and supply is not keeping up. But, all of that good news could be what makes us shy away from moly right now.

Good News can be Bad News

As investors, we always have to look at the risk/reward situation.

 Moly is in demand and new production is lagging, there just isn’t a big upside here. Moly prices have held up relatively very well during the recent downturn and many moly stocks have too. That’s good for current shareholders of moly companies, but not good for investors looking to get in now.

This year and 2009 should be good years for moly. However, that’s all expected to change in 2010. Freeport McMoRan (NYSE:FCX) has a new mine expected to increase world moly supply by 2%. In 2011 and 2012 there is even more new moly supplies slated to come on line.

The upside for Moly over the short-term is appealing, but over the medium and long term, the situation is not nearly as strong. High prices are the solution to high prices. In this case, high prices have attracted a lot of mine developers into new moly projects. Since we value stocks using long-term expected cash flows, new supplies will likely push moly prices down and reduce long-term cash flows, starting in 2010.

The moly industry even admits it. Jonathan George, who called for moly prices to rise 20% this year, also said, “"Once a lot more of these molybdenum projects get on line in 2011-12, then you'll probably see the price come back down to the US$25-30/lb range. But in the interim, there are a lot of potential molybdenum producers that just aren't getting permits and that won't be online as quickly as they thought.”

Though a price drop is anticipated, the industry is still expecting moly prices to stay more than 300% higher than the long-run average. Clearly, there are a lot of high expectations built into the moly industry.

At the Prosperity Dispatch, we stay away from stocks that are smothered in high expectations. High expectations often lead to disappointment in the stock market.

Moly likely has a few good years ahead of it, but the good news is already built into moly stocks. As a result, the downside risk offsets any upside potential. The odds are against us and it’s best to steer clear of shares of moly producers for now.

Good investing,

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

P.S. As investors, we try to ensure that the odds are in our favor. Right now, the commodity correction is creating opportunities in a few sectors. There is one sector I am very bullish on. I believe we are only in the third inning of a long game. Follow this link to learn more.